Economic Consequences of AS 18: Related-Party Transactions with Principals versus Nonprincipals

Abstract

ABSTRACT In 2014, the PCAOB adopted a new auditing standard, AS 18 Related Parties, with the intention of enhancing auditors’ performance in auditing related-party transactions (RPTs). Using hand-collected data, we find significant reductions in both firms’ restatement risk and their engagement in RPTs following the AS 18 adoption. Such reductions are especially pronounced for smaller firms and firms having RPTs with principals, in which related persons in the counterparty of RPTs are the primary beneficiaries, such as CEOs, board chairs, or primary shareholders. We also find that smaller firms having RPTs with principals tend to pay higher audit fees post-AS 18. Our study responds to the PCAOB’s call to assess the economic consequences of AS 18. The findings suggest that AS 18 is associated with improved audit quality and reductions in auditees’ opportunistic RPT activities. Data Availability: Data are available from public sources as cited in the article and from the authors upon request. JEL Classifications: M10; M40; M41; M42; M48.